Defense contractors go offshore to skip taxes, GAO says

Defense contractors expanded their use of offshore facilities from 2003 to 2008 mostly to avoid paying payroll taxes, GAO said in a new report.

U.S. defense contractors’ growing use of offshore subsidiaries from 2003 to 2008 allowed the Defense Department to save money on contracts but also resulted in the loss of U.S. tax revenue and unemployment benefits for some U.S. workers, according to a new report from the Government Accountability Office.

The 29 largest publicly traded defense contractors increased their use of offshore subsidiaries by 26 percent from 2003 to 2008, the Jan. 26 report states.

Those subsidiaries helped the contractors reduce taxes, in part by avoiding Social Security and Medicare payroll taxes for U.S. workers hired at the foreign subsidiaries, GAO auditors said.

About a third of the contractors also decreased their effective U.S. corporate tax rates in 2008 in part through the use of foreign affiliates, lower foreign tax rates and indefinite reinvestment of foreign income outside the United States.

As a result, contractors with foreign branches were able to underbid their competitors for DOD contracts. “This practice allowed contractors to offer lower bids when competing for certain services and thereby reduce costs for DOD,” the auditors wrote.

On two of the contracts GAO reviewed with offshore work, DOD saved $110 million annually, the report states.

But there were negative effects for the U.S. Treasury. The contractors generally used those offshore facilities to avoid payroll taxes that would have contributed to the Social Security and Medicare trust funds.

Some of the contractors began paying the payroll taxes starting in 2008 under the Heroes Earnings Assistance and Relief Tax Act, but they sought reimbursements from the Pentagon for those payments. In four case studies reviewed by GAO, the contractors requested $140 million in reimbursements.

The use of offshore subsidiaries also reduced unemployment benefits for U.S. workers. GAO auditors reviewed documents for about 140 former employees of several contractors who were denied unemployment benefits in 2009 because the contractor was deemed a foreign subsidiary.

DOD officials are aware of the costs and benefits of contractors’ offshore subsidiaries.

“In contracts we reviewed, evidence of offshore subsidiaries was present in contractor labor rates, cost accounting disclosures and contractor price proposals,” the report states. “Contracting officials stated that the use of offshore subsidiaries did not negatively impact contract schedule or performance.”

However, the report recommends that Congress consider drafting legislation that would address contractors’ avoidance of payroll taxes through the use of offshore facilities.

A year ago, GAO published a list of contractors that operate offshore tax havens. Large contractors with such subsidiaries include Oracle Corp., which operates in 77 tax havens; Boeing Co., in 38; Dell Inc., in 29; BearingPoint Inc., in 28; and Computer Sciences Corp., in 21, the report states.

On the other hand, 34 of the 100 largest federal contractors have no offshore havens, including Lockheed Martin Corp., Northrop Grumman Corp., Raytheon Co., SRA International Inc. and Unisys Corp., the report states.